Business Expense Deductions: DOs and DON'Ts to Protect Your Write-Offs

If you're claiming deductions for business-related expenses, especially meals, vehicle use, or home office costs, expect the IRS to scrutinize them. A recent U.S. Tax Court decision serves as a cautionary tale on the importance of documentation and the risks associated with noncompliance.

A Case in Point: T.C. Memo. 2024-82
In this case, the taxpayer operated a software installation, training, and consulting business, claiming substantial deductions across multiple years. However, the IRS disallowed a significant portion of those deductions, and the Tax Court upheld the IRS's findings. Here's why:

Meals and Entertainment
The taxpayer deducted nearly $9,000 for meals in one tax year, claiming they were "working lunches" with collaborators. She submitted only bank statements as proof.

Court's response: Insufficient. Statements alone didn't substantiate the business purpose or the relationship with those she dined with. As the court emphasized, "The cost of eating lunch during the workday is not, without more, a deductible business expense."

Supplies
She claimed over $17,000 in supplies over two years. While she testified these were for office equipment and materials, receipts submitted:

• Were dated after she had already closed her business
• Included purchases such as soda dispensers and gift cards

Court's ruling: Many appeared personal and fell outside the tax years in question.

Home Office Deduction
The taxpayer deducted over $21,000 across two years for home office use. However:

• She provided no evidence that her home was the principal place of business
• She admitted that she was frequently on-site at client locations
• She failed to show that any part of her home was used exclusively for business

Result: Deduction denied.

Other Disallowed Expenses
These included attorney's fees, utilities, hotel stays, and vehicle expenses, all of which were rejected due to a lack of detailed records or insufficient evidence that they were business-related.

Best Practices: DOs and DON'Ts
To protect your deductions and avoid costly penalties, follow these substantiation rules and habits: 

DO:

• Maintain detailed, contemporaneous records
  For each expense, log the amount, date, location, business purpose, and individuals involved.
• Use a consistent process
  Require employees to submit weekly or monthly expense reports, accompanied by proper receipts.
• Separate business from personal spending
  Use dedicated bank accounts and credit cards to track business expenses.
• Utilize apps or software to track vehicle mileage and business meals in real-time.

DON'T:

• Rely solely on bank or credit card statements as proof
• Wait until year-end or audit time to recreate logs
• Claim expenses that are only partially related to business use
• Assume that an IRS examiner will give the benefit of the doubt, because they won't

Stand Up to Scrutiny
Proper documentation isn't just about satisfying the IRS; it also gives you a clearer view of your actual business costs, helps with budgeting, and reduces your audit risk.

And if disaster strikes and records are lost (fire, theft, or flood), you may be eligible to estimate some deductions under the Cohan Rule, which allows approximations if you can demonstrate a reasonable basis.

Please let us know if you'd like to implement a more effective tracking system or have any questions about which records to retain. It's never too early to get audit-ready.